2023-03-28 05:46:10 ET
Summary
- Western Midstream has an attractive position in the Delaware Permian.
- The balance sheet is in good shape and the company plans to pay an enhanced distribution in Q2 2023.
- WES stock is among the cheapest in the midstream space despite its strong characteristics.
Western Midstream ( WES ) has done a nice job of turning itself around, and is one of the cheapest stocks in the midstream sector.
Company Profile
WES is a gatherer and processor (G&P) primarily for its parent and Warren Buffett's favorite Occidental Petroleum ( OXY ). Buffett owns nearly 25% of OXY's outstanding shares and has been granted regulatory approval to purchase up to 50% of the company.
Over 93% of WES' contracts are fee-based, while over 80% of its cash flows are supported by minimum volume commitments (MVCs) or cost-of-service contracts. WES operates primarily in two basins: the Delaware and the DJ.
Approximately 55% of its EBITDA comes from the Delaware, while 29% of its EBITDA comes from the DJ. Other assets contribute about 8% of EBITDA, while equity investments in other systems that are generally operated by other midstream companies make up 8% of EBITDA.
In the Delaware, WES has 646 miles of oil pipelines with 292,000 Bbls/d capacity and 16 treating plants. On the natural gas side, it has 1,818 miles of pipe with 1.37 BCF/d capacity and 14 processing plants. The company also has 804 miles of salt-water disposal pipelines with 1.3 million Bbls/d capacity. Approximately 98% of WES' oil volumes in the Delaware come from OXY, while 44% of its natural gas volumes come from its parent.
In the DJ, the company gathers high-vapor-pressure crude oil from the Wattenberg field and stores it in two 250,000-bareel storage tanks. It has 454 miles of crude pipelines with 155,000 Bbls/d of stabilization capacity, along with 6 treatment plants. Meanwhile, it has 2,526 miles of natural gas gathering pipelines, with 1,750 MMcf/d capacity and 16 processing plants. 100% of its oil volumes come from OXY, along with 54% of its natural gas volumes.
Opportunities
Since the start of 2020, WES has retired $1.65 billion in debt, bought back $930 million in stock, and paid out nearly $2 billion in distributions, so the company just needs to keep executing. Despite that, it is one of the cheapest MLPs in the space trading at under 7.5x 2023 EBITDA.
The Delaware is perhaps the most attractive oil basin in the U.S., so WES should continue to have plenty of opportunities to serve its parent, as well as 3rd parties operating in the region. In August , OXY announced an extended JV with EcoPetrol to include some acreage in the Delaware, saying: "In the Delaware Basin, we have the opportunity to bring forward the development of high-quality acreage that was further out in our development plans." This should be good for WES.
The DJ, meanwhile, has had some issues, especially around permitting. OXY has been only running one rig due to the issues, but they added a second rig late in 2023.
On its Q4 call , OXY CFO Robert Peterson said:
Our work positioned us to add back 2 rigs in the DJ by the end of 2022. Given the reduced activity levels over the last few years, our Rockies production is likely to be lower in 2023 than last year. Production is expected to stabilize in the second half of 2023 once the benefits from the additional rig picked up in the fourth quarter of last year fully materialize.
Setback rules in Colorado typically lead to a pad development approach with a linear time-to-market cycle as compared to simultaneous operations in other shale plays. This operating environment creates negligible additional costs for our development, but this year is expected to have a noticeable impact on time-to-market as our activity ramps up. The DJ Basin remains an exceptionally high return asset for Oxy, and we welcome the return of sustaining capital levels to that business, which was predicated by the regulatory certainty and permitting efficiency we are now experiencing in Colorado."
For his part, on its Q4 earnings call , WES CEO Michael Ure said:
I think you've started to see a lot of different approvals that have come in the basin, both within our footprint as well as other footprints in the area. As we sort of expected, it would take a little bit of time for people to work through the process to understand how it might function. And thus far, people have been successful getting approvals. And so as a result, I think your observation is exactly correct around our producers being more optimistic around what else they can do there. Again, we're expecting to save off the declines in the DJ during 2023. And then the impact on cost of service is a reflection of future expectations of increased volumes overall in the DJ as a whole."
Oxy stabilizing its DJ product and then eventually growing it would be a big boost for WES.
Additionally in October , WES and OXY announced a letter of intent to explore opportunities for carbon capture. This is still early, but presents a good long-term opportunity for the midstream operator. I don't think WES is as far along with this opportunity as some others in the space, such as EnLink ( ENLC ), but this is a real area of growth that midstream operators can pursue.
WES ended the year with leverage of 3.1x. As a result, it is now looking to increase its distribution above its $2.00 base distribution as well as buy back units. Currently, it plans to pay an additional 36-cent enhanced distribution in May after an asset sale.
Risks
WES' primary assets are in oil basins, which of course exposes it to volume risk associated with oil prices and the broader economy in general. While the bulk of its revenues are fee-based and it has MVCs and cost-of-service contracts on 80% of its volumes, this is still a risk. It projects that a $10 change in the price of crude could impact its EBITDA by $30 million.
It also relies on its parent OXY for the bulk of its revenue. OXY owns about 48% of WES, which it acquired when it purchased Anadarko in 2019. The oil giant has sold WES units in the past. Last year it has sold 10 million units back to WES, while in March 2021 it sold 11.5 million in an underwritten offering. The relationship looks solid and OXY has a strong balance sheet and doesn't need cash, but given that WES came along with the Anadarko deal, the reliance on OXY does have some risk.
Perhaps the biggest risk to WES is its operations in the DJ. It's a smaller basin whose overall production peaked in November 2019. Rigs in the basin averaged 53 in 2019 before dropping to an average of 6 between May 2020 through January 2021. Recently the basin has seen between 19-21 active rigs.
A new 2021 regulation in Colorado that requires a 2,000-ft drilling setback has made the permitting process for drillers much more difficult in the basin. That said, the total number of rigs are picking up, and OXY just added a second rig. As of now volumes are still on the decline, although they should start to stabilize later this year.
Valuation
WES currently trades at about 7.3x the 2023 EBITDA consensus of $2.1 billion, and 6.9x the '24 consensus of $2.23 billion.
Its FCF yield is over 12.5% for 2022. The stock yields 8% based off its base distribution.
WES is among the cheapest stocks in its peer group, despite its strong recent performance.
Conclusion
WES is a solid G&P that has a wide footprint in the best basin in the U.S. - the Delaware Permian - to go along with a strong parent. There should be plenty of growth opportunities here going forward. While I don't love its exposure to the DJ, the basin is seeing some improvements with permitting issues and offers some optionality as things begin to improve.
The company has done a tremendous job on the capital allocation front, taking a balanced approach of paying down debt, buying back units, and executing growth projects. It cut its distribution in half in early 2020 but began increasing it in 2021. It also has very termed out debt, with the bulk of it at attractive rates not due until between 2030 to 2050.
Trading at under 7.5x '22 EBITDA with an over 12.5% FCF yield, WES' stock is attractively priced. I think the stock is a buy at current levels.
For further details see:
Western Midstream Is A Value Play